In the futures, it's man vs. machine

Braden Janowski runs an automated trading firm and founded a financial tech company. "It's like (the movie) 'War Games,' " he says of the rise in auto trading. Photo: Erik Unger

Chicago's futures traders, forced to abandon the trading pits for electronic terminals, now face the threat of being replaced altogether by computers  or computer programmers.

Automated trading, in which computers are programmed to spot trading opportunities and instantly place electronic buy and sell orders, is taking the futures industry by storm, speeding up trades, devouring arbitrage opportunities and possibly overwhelming exchanges' computer networks. The computer programs can involve simple formulas or highly complex algorithms, usually designed to predict and exploit price spreads.

Some of the trading programs can enter 1,000 orders a second. Futures exchanges like the Chicago Mercantile Exchange (CME), which have already seen volume increase 25% through October, can barely keep up. At London futures exchange Euronext.Liffe, the server "has smoke and stuff coming out of it," jokes James Johanik, the exchange's head of technology in the U.S. Last month the CME started fining firms whose computers monopolize bandwidth by flooding the exchange with orders, many of which are never executed. The fines are also an attempt to protect the CME's human customers.

"We have to regulate the machines, or the human traders are at a huge disadvantage," says a spokesman for the CME, which has seen weekly volume grow to a recent peak of 60 million orders, up from 10 million a year ago.

Automated trading is likely to accelerate that trend. The programs not only place more orders faster than a human trader, they scour markets for opportunities around the clock and remove the human-error risk that a trader will mistakenly enter an order or fail to spot a trading opportunity.

In the futures markets, those opportunities can come and go in seconds. For example, a programmer could instruct a computer to watch for a price discrepancy between a U.S. Treasury futures contract and its underlying T-bond. That spread might appear and disappear faster than a human could point and click to make an electronic trade; a computer could enter several orders to capture the spread before it closed.

That means in some cases traders are being squeezed out of a job, or being relegated to sit and monitor a computer as it makes the trading decisions they once controlled.

"The bar keeps rising on what is considered menial," says Braden Janowski, who runs a Chicago automated trading firm, Rockstar Capital Inc., and founded Greenline Financial Technologies Inc. "When the edge goes away for the human traders, they stop doing it and it's just the computers competing with each other. It's like 'War Games,' " he says, referring to the 1983 Matthew Broderick movie.

Hardly anyone predicts the extinction of human traders, who will be needed in the case of unpredictable events. "Algorithms don't react to earthquakes or Sept. 11," says Harrell Smith, an analyst at New York-based research firm Celent Inc. Still, many firms that acquire auto trading software have fired traders.

GROWING 'DRAMATICALLY'

Of the futures exchanges, only Euronext.Liffe has been able to quantify how many of its contracts are traded by computers: 20%. That's a 40% increase in the last 12 months. The Chicago Board of Trade and the CME won't reveal how many of their customers are using automated trading. Some industry executives estimate that 40% of futures traders are using algorithms.

Anecdotally, the experience of many software makers suggests the number could be even higher. "Every single client is increasing the amount they are auto trading," says Linda Bracken, managing director of YJT Solutions, a Chicago trading-technology consultant. "We're seeing volume just skyrocket." John Barun, CEO of Capital Markets Consulting LLC in Chicago, says his company's revenue should increase 70% this year, after growing 100% in 2004, and the number of firms for which he is developing custom software is growing "dramatically."

The software isn't cheap. Mr. Barun says getting started in automated trading can cost up to $1 million or more. But that expense can be offset by the reduced cost of paying human traders.

PROGRAMMERS WANTED

"Cost is a big part of it," says Patrick Kenny, Chicago-based managing director for North America at Patsystems PLC, a London firm that is one of the largest providers of auto trading software. "Small firms used to have a lot of staff on the floors."

The small firms have already altered their hiring practices. Trading jobs used to require only the ability to think fast and take enormous risks. Now, in many cases, computer programming is an added qualification. "Some of the (trading) shops we work with won't bring on a trader if they don't know how to program," says Michael Felix, director of marketing at Chicago-based software developer Townsend Analytics Ltd.

Technology staffers are becoming more valuable as well. "A few years ago, a firm may have had 20 to 30 traders and one IT guy," says Steffen Gemuenden, managing partner in Chicago at German technology firm RTS Realtime Systems A.G. "Now firms are half and half and I think it's going to shift even more to IT."

One thing the computer programs haven't changed about futures trading: the extreme risks. In fact, if a computer is programmed with a faulty strategy, the downside can be even greater. "The biggest risk is that you come up with a strategy and turn it on full-bore and you could blow out and lose all of your profits in one five-minute period," says Mr. Barun. "It's something that some firms have a very firm grasp on but others are a little bit more of the gunslinging types."